China is paranoid about Covid-19. And this is problematic for the rest of the world. Despite the fact that they have managed to log 8.1% growth for 2021 (2% above the target they set themselves in the middle of last year)- or perhaps because they have managed the pandemic better than anyone else, they are taking next to zero chances at the slightest signs of the emergence of cases in the country.
Even with just a handful of cases discovered in Dalian, Tianjin restrictions have started and with delays in Beijing all ships are heading towards the Shanghai port. Since they are amongst the 20 largest ports in the world the cargo that they would normally handle is creating congestion at the re-routed ports and adding weeks of delay for goods globally. Furthermore, production has been halted by many firms on account of the stepped up testing and the clampdowns ahead of both the Chinese New Year as well as the Winter Olympics to be held in Beijing.
The consequence for countries that rely on Chinese factories for supply is obvious and is being felt across the Pacific Ocean in the United States. Inflation there is at levels not seen for 39 years. They are facing the double whammy of higher costs for landed imports (along with delays) as well as wage re-negotiations in several states which will push up the employment costs for firms. This will only encourage the Federal Reserve to start their rate hikes earlier and continue it for longer than originally foreseen. This and the withdrawal of the liquidity support will impact equity valuations but- more importantly, growth rates. This does not mean that they should avoid this because the price of inaction now will be raised inflation expectations which get built into costs. The fear of a stagflationary scenario developing is also a frightening prospect for the US. Commentators are now- hyperbolically, comparing the rise in US to the period in the 1970’s when the oil crisis led to runaway inflation which was tamed only by interest rates that peaked at 20% in June 1981. This is a direct consequence of inflation being at levels not seen since 1982. It should be remembered that Paul Volcker, the Federal Reserve Chairman at that time, was forced to act against an inflation rate that peaked at 14.8% in March 1980. Meaning; that real interest rates had to choke the oxygen out of inflation for long after it was at its worst. Apart from high oil prices there was also the problems of large fiscal deficits and lax central bank policies- two out of three which are in evidence today. Oil still has a way to go before it starts causing real pain.
The anticipation of a genuine and sustained rise in inflation is creating some trepidation amongst investors and there is a subdued start to 2021 in terms of inflows into equity when normally January sees large buying which drives outperformance. This year people are playing a wait and watch game with anywhere between 4 and 7 rate hikes priced in; there are some takers for a 50b.p. hike in March itself. US Treasury yields are at 2 year highs and climbing.
Complicating matters is the shift from a focus on economics to a focus on politics across the globe. The rise of nationalistic closed door policies is threatening to erase the golden straight-jacket of policy dictated by economic priorities that characterised much of the globe for the last 40 years. This had largely helped kill inflation as a major concern (along with disinflation imported from moving global production sites to China) as countries focused purely on economic growth. There is now a resurgence in protectionism as China, India and the US have erected barriers to promote local production. The UK leaving the EU has created impediments to trade- a direct consequence of nationalistic fervour trumping economic logic if ever there was one. One of the consequences of this in the post Covid world is the way in which supply chains re-form. Will they go back to pre-pandemic levels or will they re-organise around the different political reality that is emerging?
The political changes being made in China- with a greater focus on domestic consumption and moving up the value chain of exports, a re-distribution of wealth (ostensibly) are all signs that China is pivoting away from one model of growth to another. They face enormous challenges ranging from water shortages to energy dependence, an ageing demographic (with 2021 seeing the lowest addition to population growth) and may compensate for this with an aggressive territorial programme. This has economic consequences in the trade ties that either get strengthened or wither away.
With a combination of economic and political vectors in play the year ahead is going to pose a lot of challenges for investors. Whilst pundits point to strong economic growth it is clear that there will be a tapering off of the rebound we saw last year and rising US interest rates will impact further growth prospects. This is possibly the endgame of the Covid-19 pandemic. Countries are already beginning to say that it’s reached the endemic stage where we will just have to learn to live with its existence. But that will mean permanent lifestyle changes- how often we go to work (data suggests that 30-40% of work may be from home in the future), the nature of employment (more flexible employment arrangements), the move towards automation so as not to have to face slowdowns, the growth of unionisation in the US; all of these will change the way that the world operates. That will then impact the way we consume without even touching on the impact of climate change awareness affecting our purchasing decisions.
If this were Hannibal’s journey across the Alps we would now be over the peaks and we’re staring into northern Italy. Ahead awaits a whole new set of challenges, new alliances and fresh possibilities. Covid-19 has been with us for over 2 years, we’re into the endgame now and it’s a completely different battleground in front of us.